Flawed Durbin Ruling Boosts Fed’s Odds:

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Flawed Durbin Ruling Boosts Fed’s Odds:

Since U.S. District Judge Richard Leon issued his shocking decision on July 31 that called for even more draconian price controls under Dodd-Frank’s Durbin Amendment, some legal commentators have given him the benefit of the doubt.

They concede the Durbin Amendment is bad law, but they say Leon was correct in his interpretation of the amendment, which basically mandates the Federal Reserve not set price caps on what banks and credit unions charge for interchange fees on debit cards at any rate higher than retailers would like to pay them.

These commentators, some of whom I respect a great deal, simply overlook the incredible sloppiness in Leon’s ruling in NACS. v. Board of Governors of the Federal Reserve. Leon’s decision oozes with unprofessional snark, misconstrues economic terms in the statute’s language, and limits its research of “legislative intent” to the “intent” of one member of Congress who voted for the legislation: Sen. Richard Durbin (D-Ill.).

Leon’s ruling also forces the Fed to construe the law in a way that almost certainly will foment a constitutional challenge—similar to the lawsuit TCF Bank filed after the Fed’s more stringent “proposed rule” in late 2010—involving the 5th Amendment property right to seek a return on capital invested.

Because of these many flaws, the Fed has a good shot at getting the ruling overturned in its pending appeal.

First, the snark. I’ve never seen a ruling with so many sarcastic asides at a party in the suit.

Care is also lacking when Leon attempts to define words in the statute. The crux of the issue is that in setting the price controls, the Durbin Amendment allows the Fed to consider “the incremental cost incurred by an issuer for the role of the issuer in the authorization, clearance or settlement of a particular” debit transaction, but bars it from including “other costs…which are not specific to a particular” transaction. This may sound somewhat clear at first read, but the term “incremental cost” is never defined in the law.

Citing just one federal court decision from 1992, Leon concludes that incremental costs mean variable, as opposed to fixed costs, and thus the Fed was allowing too many bank and credit union costs to be considered in setting the price controls. Yet Leon ignores the body of economic literature over the past few decades that define incremental costs as including at least some fixed costs.

“Incremental cost includes both product-specific variable and fixed costs of production,” wrote Ashish Lall, professor of economics at the National University of Singapore. Lall cites award-winning American economist William Baumol as providing this expansive definition of incremental costs. Lall and Baumol are picking up on an insight of Nobel Laureate Ronald Coase in his classic treatise The Firm, The Market, and The Law, that average costs do not necessarily decline if producing an additional unit requires higher fixed costs.

The Fed was in line with the mainstream of economists in giving this term this reading. If Congress really wanted the price controls to allow only for variable costs, then why doesn’t the law specifically say variable costs rather than incremental costs?

Leon tries to paper over his slipshod interpretation of the statute’s language with a strained reading of legislative intent. He cites Durbin’s repeated statements that the Fed should set price controls as stringently as possible but neglects other members who voted for the Durbin Amendment and the Dodd-Frank legislation, who then made the case to the Fed to consider more costs.

For instance, Sen. Debbie Stabenow and Sen. Carl Levin, both Democrats from Michigan, wrote to the Fed in 2011 to “urge you to consider fraud-related costs and to make every reasonable effort to mitigate any potential impact on access to banking services for low- and middle-income families and businesses.”

Given Leon’s overreach, the Fed is right not to fear taking him on in its appeal. It is also probably aware that if it doesn’t go that route and price controls become more stringent, the litigation from all parties likely will continue.

Richard Epstein, the property rights expert and New York University law professor who represented TCF, agreed with Leon’s interpretation of the statute. But Epstein reaffirmed his view that the statute itself is unconstitutional, because it deprives banks and credit unions of the property right to seek a return on capital invested guaranteed by the Due Process and Takings clauses of the 5th Amendment.